Tech Leasing for Lawyers

Keeping pace while keeping your cash flow.

By Dennis Kennedy

(Originally appeared in LAT’s sister publication, Law Office Computing.)

Remember the first time you realized the reason your neighbor was driving a new BMW? It was not because he was embezzling money from his employer; it was because he was leasing it. Nowadays, we take for granted many people with new cars are leasing them, as attitudes toward leasing and the culture of ownership change.

The next time you notice an opposing party with another new notebook computer or a competitor law firm with all new hardware, you might be seeing evidence of the growing trend of technology leasing in the legal profession. The adoption of technology leasing by lawyers and law firms should not surprise you. Many small businesses lease technology as a common practice. As many as 80 percent of all businesses use or have used technology leasing to one degree or another.

The New Popularity of Technology Leasing for Law Firms

Computer technology leasing is an attractive option because computer systems get outdated quickly. There are good reasons to keep pace with technological change. Experts consistently recommend replacing computers on a three-year schedule. After three years, the typical computer has little or no market value and no longer will be covered by warranty. Hardware costs, especially for servers, add up quickly. Large cash outlays for new purchases might be required.

All of these factors combined create a situation similar to the new car sales business before leasing became so prominent. As a result, many individuals started looking for comparable leasing opportunities for computer systems.

A new car lease is an excellent analogy when considering technology leasing. There are financial aspects of the decision — effective rates, time value of money and total costs, for example. There are economic considerations such as cash on hand and available credit. There are need factors — potential growth, future requirements, likely usage and more. Finally, there are some X factors — “moving up” to a platform you can’t afford to buy, having newer and better equipment, meeting prestige or other requirements and simply getting what you want.

While some people can make the lease vs. buy decision purely based on financial factors, most of us will make the decision as a result of more complex considerations.

The good news is: 1) Many creative leasing options are available to small businesses and individuals; 2) one or more of these options might make good economic sense for you; and 3) the so-called “smart leases” or “value leases” extend the benefit of leasing by, in certain cases, letting you bundle hardware, software and consulting services into a single monthly payment.

If you strip the business of a law practice of all its subtleties, we ultimately are in a cash-flow business. The main goal of both a new firm and an existing practice is to reach and maintain a positive cash flow. In that light, technology leasing deserves a close look as a way to spread out expenses and create a more predictable cash flow, while also offering the benefit of keeping you current on technology.

Leasing is especially attractive to law firms that want to stay closer to the cutting edge in technology. It smooths out their cash flow and protects their working capital while avoiding large periodic expenses for new technology purchases.

Technology as a Utility Cost and Other Financial Considerations

St. Louis-based legal technology consultant Bill Coplin explained the benefits of leasing a few years ago, and the same principles apply today. His approach goes to the root of the issue. He said leasing allows law firms to “fix their costs per seat” for technology on an ongoing basis. He further said, “All firms should begin to look at computer costs as utility costs and not capital costs.” A lease allows you to stay at an appropriate level of technology for a set monthly cost you can budget for ahead of time.

However, the lease analysis often is far less sophisticated or subtle. Studies consistently show technology expenses have grown to roughly 5 to 6 percent of the average law firm’s total expenses. At these levels, paying cash might no longer be a viable option.

Even firms that traditionally only pay cash or wait to purchase technology until the proverbial “good year” will look at leasing options once they see the dollars required for a purchase and factor in software, training, support and other services. Often those firms will relieve costs by cutting corners on other parts of the package — most often training — and not realize all the hoped-for benefits of a technology upgrade. This is being penny wise but pound foolish.

“Smart” leases give you a way to roll services, hardware and software into your monthly lease payment. This type of bundling allows a firm to consider an appropriate monthly cost of technology and aim a little higher on hardware, without cutting corners on training and support. For example, a bundled lease might even provide a way for a smaller firm to afford a high-level consulting firm, better software or a robust network infrastructure.

Can you just walk into a leasing company and expect to obtain a lease? Not necessarily. You still have to show credit worthiness. Be aware that some technology leasing companies might require more financials than a small or new law firm can provide. On the other hand, vendors such as Dell, Hewlett-Packard, Microsoft and others offer leasing options to their small business customers as a standard option and might prove to be better alternatives for certain firms. In each case, however, leasing companies and vendors probably will be more willing to work with you than traditional banks.

The Leasing Mentality

In many law offices, the newest and best technology usually are the copy machines, which typically are the only pieces of equipment a firm is leasing. Lawyers, however, tend to think of computers as capital costs or as equipment they must own. Are copiers really so different?

A lessee is a user, not an owner. We often are caught up in the notion of ownership. However, in the case of the office itself, copiers and our cars, we are quite comfortable with leasing. Technology leasing requires a similar approach, or a “leasing mentality.”

In other words, if you currently are leasing your car, you might be very receptive to leasing your computer. If, on the other hand, you are proud of telling people your car has 150,000 miles on it, and you have not yet noticed you tend to start out many conversations with “My mechanic was saying the other day …” you might have more difficulty.

As a general rule, younger lawyers, lawyers starting a solo- or small-firm practice and those with small bank accounts will tend to have a leasing mentality.

Leasing Advantages and Disadvantages

Advantages of leasing include:

• reducing your initial investment and capital expenditures
• spreading out your technology costs over time
• making your technology costs more predictable for budgeting and other purposes
• giving you favorable tax treatment in certain cases
• making it easier for you to upgrade computers and systems
• allowing you to bundle software and service costs into monthly lease payments
• reducing the impact on your cash availability and credit limits
• qualifying for a lease more easily than for a loan
• lessor handles disposal of old equipment
• better terms than those available for bank loans or other financing
• giving you the convenience of a one-stop shop.

Disadvantages of leasing include:

• not owning your equipment
• potentially larger total outlay of funds over the term of the lease
• cancellation fees that likely will apply if you want to get out of a lease
• onerous provisions that might not be applicable to your firm’s needs
• financial viability of lessor might affect your lease arrangement
• making it too easy to add additional equipment
• not getting desired tax benefits if the lease isn’t carefully crafted
• pricing, which might be based on prices substantially higher than what you could buy the equipment for
• high finance rate
• becoming “captive” to one provider in the case of vendor leases.

Getting Your Toes Wet

Some law firms test out the idea of leasing with notebook computers before moving to leasing desktop computers. The duration of leases for notebooks is typically 18 to 24 months, while leases for desktop computers typically last 24 to 36 months.

Leases can be creative, customized and flexible. A leasing arrangement might involve a master lease schedule with a phase in of equipment. Another type of lease might allow you to add equipment on an as-needed basis and simply incorporate new items into the lease arrangement.

As mentioned previously, leasing companies, hardware vendors and some consulting firms can put together a package that includes hardware, software and consulting services into a single monthly lease payment. Some leasing companies, however, might require a fixed percentage of the lease to be based on the hardware.

Another good starting point to experiment with leasing is with a new network server. I know of several lawyers who received quotes for server setups they wanted, but the quotes greatly exceeded what they had set aside for their entire technology budget. Buying a server is far more complicated than simply buying the “box.” As a result, firms often cut corners on memory, backup, redundancy and other important features when they make the initial purchase. More effort is spent trying to eke service out of badly outdated servers as replacement time approaches. Given the vital importance of stable and well-run networks to today’s law firms, this approach creates vulnerabilities at precisely the place you want to be strongest. A lease arrangement for your server will let you experiment with the leasing concept in a limited way, but will allow you to take advantage of cost-spreading and other benefits of leasing to help you get the sufficient and reliable network infrastructure you need.

End of Lease Options

What happens at the end of a lease? Despite the available purchase option, the purchase of three-year-old, heavily used equipment at the end of a lease term is relatively uncommon. Typically, a lessee simply will order new replacement equipment and have the lessor take away the old equipment. In other cases, the lease term is simply extended with the monthly payment maintained at the same rate for any new equipment. In effect, the lease never ends. The lessee typically will work out the various details and options for implementing a new technology package with a leasing company well before the lease term expires.

By working under a master lease agreement or by staggering the terms of multiple leases (sometimes referred to as “layered leases”), you can get new equipment when you need it, without ever incurring a large capital investment for purchasing equipment. In some cases, you might even be able to upgrade all of your equipment with no change in your monthly cash outlay for technology.

A lease also eliminates the growing concern regarding how to dispose of old computers properly. The leasing company will take back your computers and handle disposal. On the other hand, it’s vital you have your data “wiped” or electronically “shredded” from hard drives before turning computers back to the lease company.

Tax Issues

Leases, especially those that bundle hardware, software and services, raise a number of tax issues. I want to highlight two key points about taxes.

First, there are some significant tax consequences arising out of the different methods of leasing. I highly recommend consulting your tax advisor before entering into a lease, especially since tax laws relevant to the leasing decision have changed recently. One reason to use a computer leasing company is its expertise on tax issues and its experience and flexibility in structuring leases. As a general matter, you will want an “operating lease” rather than a “capital lease” and a fair market value end-of-lease purchase option rather than a $1 end-of-lease purchase option. Bundling software and services into a hardware lease also might have significant tax consequences.

Second, calculating the relative costs of buying versus leasing requires you accurately consider the impact of taxes and the time value of money. Simply adding up the total of all lease payments and comparing it to the cash payment required will not give you accurate information with which to make a decision. In addition, changes in Section 179 raised the total amount of equipment that can be expensed in the first year of a business, which might lead to completely different financial conclusions for a start-up and an ongoing firm.

Evaluating Leasing Companies

As I suggested above, entering into a leasing arrangement probably will result in a long-term business relationship. In doing your due diligence on a leasing company, look closely at:

• The length of time a leasing company has been in business and its reputation in the market.
• The leasing company’s financial strength and credit worthiness.
• Does a firm keep its financial paper? A company that services its own leases is preferable to a lease broker.
• The expertise of the leasing representative.
• Make sure there are not hidden costs, such as closing costs, “documentation fees” or other service charges.
• The administrative abilities of the lessor, particularly its record of paying vendors on time. A leasing company with a bad track record with vendors might make those vendors less willing to work with you.
• Knowledge of the legal business. A leasing company with expertise and experience in the legal industry should be able to come up with more creative options and customize a leasing arrangement for you with a greater sensitivity to lawyers’ concerns.

Don’t Cut Corners

Clients are putting pressure on firms to keep current with technology. Once a firm spends a significant amount of money on computers, there is a reluctance to make the same kind of cash outlay within a few years. As a result, firms have a tendency to hang on to outdated technology or to cut corners on training and support.

For existing firms, leasing offers a path to make those upgrades and maintain a good technology platform without making significant capital expenditures every few years. For new firms and solos, leasing offers a great way to reduce initial start-up costs, acquire enough technology to create a competitive advantage and create positive cash flow.

The advantages and disadvantages of leasing might result in firms reaching different conclusions for different technology at different times, so it’s important to analyze the leasing option carefully each time and not make a permanent decision always to buy or always to lease.

In many cases, a mixed approach to buying and leasing will make good sense. The path to avoid is the one that doesn’t consider any leasing at all. Technology leasing, including bundled arrangements, might be one of the wisest decisions you make for your law firm.

Nine Leasing Tips

1. Consider the bundling option. Interestingly, a hardware vendor, a software vendor or a consultant each might have the ability to combine hardware, software and services into a single lease payment. Ask each of them what options are available.
2. A diversified approach makes the best sense. A combination of leases, purchases, durations and providers often will produce the best overall results.
3. If you are committed to certain providers, the convenience of dealing with one arrangement might outweigh other benefits of diversification for you, but be sure to revisit this issue from time to time.
4. Learn about leasing options from Web sites and other resources before you ask the vendor about them.
5. Proceed as if you will make a purchase and arrive at a final price before announcing you want to consider leasing to get a better price.
6. Leasing will work best for you if you use it as a way to upgrade and keep your technology current.
7. If you don’t have a leasing mentality or can’t see technology as an ongoing monthly cost of doing business, much like a utility, reduce your stress and stay in your comfort zone by continuing to purchase equipment. However, remind yourself you might give up competitive advantages by sticking to your old ways.
8. Keep in mind the powerful impact leasing can have on your cash flow and consider whether leasing will enable you to free up money for other needed investments, such as in people or marketing. What are the opportunity costs of using large amounts of cash for technology purchases? What else might you do with that money? Why not use leasing as a way to do both?
9. Make sure you understand the lease arrangement and that the lease agreement actually reflects what your agreement is.

Key Terms in Leases

Once, when leasing a car, a salesperson asked me if, as a lawyer, I wanted some time to read all the provisions carefully. I asked, “Will we be able to change anything I don’t like?” Sheepishly, the salesperson said, “I really doubt it.” In that case, I said, it probably would not be an effective use of my time to do a complete review of the lease agreement.

In some cases, you or your firm will have limited, if any, flexibility in negotiating a technology lease. In other cases, you might have enough leverage to get some concessions. Here are a few provisions to pay attention to:

• duration of lease — is it appropriate for the leased equipment
• total cost of lease and all additional charges
• cancellation options and penalties
• assignment provisions for both you and the lessor
• automatic renewal provisions
• permissible rate increases
• ability to exchange or update to more modern equipment
• service or maintenance charges or plans, especially mandatory plans
• contract language required for desired tax treatment.

DENNIS KENNEDY ([email protected]) is a computer lawyer and consultant based in St. Louis. He speaks and writes frequently on legal, technology and Internet topics and was named the 2001 TechnoLawyer of the Year by TechnoLawyer.com. His Web site at www.denniskennedy.com collects many of his articles and is the home of his blog.